Race to the bottom

Key points

Upbeat outlook for the global economy, supported by widespread policy easing following falls in inflation.

Increasingly positive on prospects for risk assets, and continental European equities in particular, as bond yields fall.

The dollar will strengthen further after a period of consolidation as US interest rates rise.

The global economy is set for another solid year in 2015 with output expanding by between 3.0 and 3.5 per cent. However, output will continue to expand sluggishly in advanced countries by historical standards given the stage of the economic cycle. While we see downside risks to growth in the euro zone, China and Japan, central banks stand ready to loosen policy if needed.

Increasing appeal of risk assets

With the European Central Bank (ECB) having commited to buying €60 billion (£43.9 billion) of assets a month until September 2016, German ten-year bond yields have fallen to 0.16 per cent1. As a result, we have become more optimistic on prospects for risk assets such as equities and credit, particularly in developed markets, as investors take more risk in the hunt for extra yield. We focus on regional selection. Subdued inflation expectations should support government bonds too.

Euro-zone equities to outperform

We favour continental European and Japanese shares – especially the former – compared with US ones. While the surge in global equity valuations seen since 2009 seems to have further to run, US valuations are starting to look stretched, although they remain attractive relative to the very low bond yields on offer. Eurozone shares seem to offer better value, given signs of an economic recovery and the extra liquidity being created by ECB bond buying. We expect ‘peripheral’ markets such as Italy and Spain to outperform, especially if the euro continues to weaken. Both countries’ economies are particularly sensitive to the exchange rate and their stock markets tend to outperform other euro-zone markets during bouts of currency weakness.

US dollar rally to resume

The dollar has soared over 20 per cent since last July against a basket of other leading currencies. Having lost momentum in recent weeks, we expect the rally to resume later in the year. Despite softer economic data in the first quarter, the US economy should still grow by around three per cent in 2015. Cheaper oil, a stronger dollar, sustained job gains and higher equity valuations and house prices should all help to boost consumer spending.

The US Federal Reserve is set to hike rates for the first time since 2006 this year. Although a recent run of weaker economic numbers may persuade it to wait until September or even later, the prospect of US rate rises versus more policy easing in the euro zone and Japan reinforces the US currency’s credentials.

Meanwhile, shifts into higher yielding assets, or so-called ‘carry trades’ involving borrowing cash in one currency to invest in assets denominated in another, will keep downward pressure on the euro and yen for some time.

Treasuries vulnerable to data pick-up

A myriad of central banks have eased policy this year, taking advantage of falling inflation to promote growth. Much of the increase in US Treasury prices of late can be explained by the disinflationary impact of a rising dollar. The extent of the rally suggests US government bonds could struggle in the near term. There is little doubt that valuations look expensive and Treasuries are vulnerable to a pick-up in US economic data.

Having said that, there remains a bearish consensus in bond markets – and the US and UK in particular – due to expectations US rates will rise later this year. This may limit any near-term downside. And we are more positive on the longer-term outlook for Treasuries. Policy tightening is likely to be more gradual and drawn out than expected in the US while the bias elsewhere is to ease policy.

1 Source: Bloomberg, as at 23 April 2015

Important information:

Except where stated as otherwise, the source of all information is Aviva Investors Global Services Limited (“Aviva Investors”) as at 23 April 2015. Unless stated otherwise any opinions expressed are those of Aviva Investors. They should not be viewed as indicating any guarantee of return from an investment managed by Aviva Investors nor as advice of any nature. The value of an investment and any income from it may go down as well as up and the investor may not get back the original amount invested.

Issued by Aviva Investors Global Services Limited, registered in England No. 1151805. Registered Office: St. Helen’s, 1 Undershaft, London EC3P 3DQ. Authorised and regulated by the Financial Conduct Authority and a member of the Investment Association. Contact us at Aviva Investors Global Services Limited, St. Helen’s, 1 Undershaft, London EC3P 3DQ. Telephone calls to Aviva Investors may be recorded for training or monitoring purposes.

RA15/0592/300916

Stewart Robertson

Senior Economist (UK and Europe)

Main responsibilities

As part of the Strategy Team, he is responsible for economic research and analysis of the UK and main European markets.

Experience and qualifications

Prior to joining Aviva Investors, Stewart worked for Lombard Street Research, where he specialised as a UK economist. He also held positions at Coopers & Lybrand and Unilever plc. Stewart began his career as an economist in 1987, before joining financial markets in 1993.
Stewart holds a BA (Hons) in economics from Liverpool University and an MSc in economics from the London School of Economics and Political Science.